FX Options Insights 06/11/24

Ahead of the U.S. election, forward-looking FX options were bracing for heightened FX volatility, reflected in elevated risk premiums. However, post-election, these premiums have swiftly shifted to focus on the early months of a Donald Trump presidency after the Republican candidate declared victory. Gamma demand drove shorter-dated expiry implied volatility to long-term highs in the lead-up to the election, as close polling indicated a potentially prolonged process and increased FX volatility. However, Trump's early lead quickly alleviated some of these concerns, resulting in a rapid reduction in option premiums. FX option traders now appear to be reallocating their volatility risk premiums to cover the initial months of the new presidency, from late January through April, particularly in Asian FX markets. This period is expected to coincide with potential trade policy actions by Trump, with China identified as a prominent target. Dealers report a marked increase in demand for options in this timeframe, aiming to hedge against the risk of intensified FX volatility.

For those trading currencies, the threat of a trade war may prompt a more defensive stance, favoring safe-haven assets and potentially strengthening the world reserve currency in times of crisis. However, the more widely held an asset is, the less safe it becomes, as evidenced by the sharp falls in the dollar in 2022. This could make gold less attractive and benefit currencies like the Japanese yen or Swiss franc, which are less crowded trades. The euro, as the natural counterpart to the dollar, could become more appealing if it drops further in reaction to potential tariffs on the eurozone's auto industry. Conversely, the pound, which has been a popular carry trade, may be one of the bigger losers in more volatile conditions stemming from any trade dispute.